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French markets rebounded after Marine Le Pen\u2019s National Rally party finished with a smaller margin of victory than indicated by polls, spurring a relief rally across the nation\u2019s assets.<\/p>\n
The CAC 40 stock index surged almost 3% as Le Pen\u2019s opponents started strategizing on how to keep the far right out of power. Ten-year government bonds opened higher, narrowing the spread over 10-year German securities by as much as seven basis points \u2014 trimming a more than 30 basis point surge over the past two weeks.<\/p>\n
The euro edged up, climbing as much as 0.6% to $1.0776, though still remained 0.5% weaker than where it was before President Emmanuel Macron called the snap vote in early June. Credit risk in the region plunged.<\/p>\n
Le Pen\u2019s party dominated the first round of voting Sunday. But Macron\u2019s centrist alliance and the left-wing New Popular Front are now weighing whether to pull candidates from the second round to keep the far-right National Rally from securing an absolute majority on July 7.\u00a0<\/p>\n
\u201cThe Leftist parties have indicated that they will withdraw candidates who came third in the 1st round to avoid splitting the vote next weekend,\u201d said Jane Foley, head of FX strategy at Rabobank.<\/p>\n
\u201cThis should limit the ability of the far-right to win an outright majority in parliament. This is providing some relief this morning, though with uncertainty high, markets are likely to remain wary,\u201d she said.<\/p>\n
Investors are concerned that Le Pen\u2019s party will pursue expansive fiscal policy. At a projected 5.3% of output this year, France\u2019s budget deficit already far exceeds the 3% of economic output allowed under European Union rules and its debt is expected to rise to 112% of economic output in 2024, according to the International Monetary Fund.<\/p>\n
\u201cWhile we expect some relief-tightening in OAT-Bund spreads, there is still uncertainty ahead,\u201d said Evelyne Gomez-Liechti, a strategist at Mizuho. \u201cOur analysis suggests that any significant tightening will be unstable given worrying debt sustainability dynamics.\u201d<\/p>\n
Le Pen\u2019s National Rally locked up 33.2% of the vote, according to interior ministry figures. The New Popular Front got 28% and Macron\u2019s coalition got 20.8%.<\/p>\n
If alliances forming to block Le Pen from absolute power start to look credible, French markets would likely recover, according to Kathleen Brooks, research director at XTB.<\/p>\n
\u201cA hung parliament could make it hard to get anything done in France in the current parliament, which is exactly what the markets would like,\u201d she said.<\/p>\n
Shares of French banks Societe Generale, BNP Paribas and Credit Agricole all jumped on Monday, while the riskiest type of bonds issued by French lenders rose the most in weeks in early trading. Banks have been under pressure since Macron called the election due to rising political risk and the drop in French sovereign bonds.<\/p>\n
If the leftist alliance \u201cis aimed at blocking Le Pen\u2019s grouping from getting a majority in the crucial second round, it has wide-ranging implications for the France-German spread and indeed the euro. If the upshot is that we will get a more centrist government, it would be positive for the currency and herald a narrower spread.\u201d<\/p>\n
\u2014 Ven Ram, cross-asset strategist for MLIV<\/p>\n
Still, strategists warn there is likely volatility ahead, as the electoral calculus gets complicated in the runoff when parties can strategically withhold candidates in certain constituencies to give a boost to a centrist hopeful.<\/p>\n
Macron\u2019s decision to call a snap vote in early June had sent markets into a tailspin.\u00a0<\/p>\n
His party \u2014 which supports large spending cuts to get France\u2019s budget deficit under control \u2014 suffered a crushing defeat in European parliamentary elections. National Rally, meanwhile, has touted some costly budget measures including lowering the sales tax on energy and fuel.<\/p>\n
Over the past three weeks, the extra yield investors demand to hold 10-year French bonds over safer German debt rocketed to more than 80 basis points, levels last seen during the euro area\u2019s sovereign debt crisis. The euro fell to its lowest since early May.\u00a0<\/p>\n
It\u2019s hard to see a \u201cmaterial and sustainable snapback,\u201d in French yields, said Peter Goves, head of developed market debt sovereign research at MFS Investment Management.<\/p>\n
\u201cUncertainties are high, French fundamentals haven\u2019t changed and the final outcome is still unknown and unknowable with the large number of three-way contests complicating matters,\u201d he said.<\/p>\n<\/div>\n